DBRS Morningstar Finalizes Its Provisional Ratings on SOHO Trust 2021-SOHO

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of Commercial Mortgage Pass-Through Certificates, Series 2021-SOHO issued by SOHO Trust 2021-SOHO:

Class A at A (low) (sf)
Class B at BBB (low) (sf)
Class C at BB (low) (sf)
Class D at B (sf)
Class HRR at B (sf)

All trends are Stable.

DBRS Morningstar discontinued and withdrew its ratings on the Class X-A Certificates initially contemplated in the offering documents, as they were removed from the transaction.

SOHO Trust 2021-SOHO is a single-asset/single-borrower transaction collateralized by the borrower’s fee-simple interest in a 786,891 sf Class A office/retail property known as One SoHo Square in the heart of the SoHo/Hudson Square submarket of New York City. DBRS Morningstar has a generally positive view of the credit characteristics of the collateral, based on the property's desirable location and high proportion of investment-grade tenancy. DBRS Morningstar believes the long-term cash flow is stable and sustainable, given the majority of the investment-grade tenants at this property use this location as their corporate headquarters and have signed long-term leases. These factors are critical as the cash flow will be less susceptible to revenue swings, making it more resilient during economic downturns, which is evidenced by the strong performance at the property throughout the Coronavirus Disease (COVID-19) pandemic where less than 1% of tenants, based on total rent, had requested rent relief. DBRS Morningstar also views the $268 million in capital expenditure over the last few years as credit positive because capital improvements often play a significant role in retaining existing tenants and attracting new tenants, as well as demonstrating a sponsor’s commitment to a property.

DBRS Morningstar has concerns about the subleasing of spaces at the property. Flatiron Health (Flatiron) has put approximately 18% of its space up for sublease and JUUL Labs (JUUL) has the entirety of its space up for sublease. Flatiron originally put up approximately 49% of its leased space for sublease during the pandemic, and has subsequently pulled back the majority of them from the sublease market. The fact that Flatiron’s sublease spaces have been earmarked to be occupied as the company grows and that the subleasing is intentional until the expansion occurs mitigates some of those concerns. JUUL has been current on all rents throughout the pandemic. Despite both Flatiron and JUUL being current on rents and continuing to pay the rents on their respective spaces, DBRS Morningstar has incorporated a partial lit/dark analysis into the valuation of the property to account for the spaces marketed for sublease. The property’s slightly-below-market rental rate coupled with its location in the epicenter of the submarket with easy access and good amenities also help alleviate some of the concerns as the property provides an attractive option for a variety of tenants in the future. In addition, DBRS Morningstar views the weighted-average remaining lease term of 9.2 years and minimal lease rollover risk of 22.3% of the net rentable area (NRA) over the loan term as credit positive because these result in a secure stream of cash flow as well as shielding the property from any short- or medium-term dislocations in the Manhattan office market resulting from the pandemic.

The all-in DBRS Morningstar Loan-to-Value Ratio (LTV), inclusive of the $120 million mezzanine debt, is high at 109.9%. The high leverage point could result in an elevated refinance risk and loss severities in the event of default. Overall, DBRS Morningstar views the property’s location favorably in that it continues to attract high-quality tenants in the post-pandemic environment because its recent renovation lifts it to Class A quality with strong submarket fundamentals.

One SoHo Square is located in a high foot traffic location on the corner of Sixth Avenue and Spring Street in the heart of Hudson Square/Meatpacking submarket, amid the desirable neighborhoods of SoHo, Hudson Square, Greenwich Village, and West Village. The submarket has seen an increased demand in leasing over the past few years, most notably from technology companies, with Google, Facebook, and Amazon taking space in the vicinity.

The property features modern infrastructure designed by Gensler and top-of-the-line amenities, including state-of-the-art roof decks with panoramic views, 12.5’ to 13’ ceiling heights, a modern building management system, and a 24/7 attended lobby. The sponsor invested approximately $268 million in redevelopment of the property and the new construction resulted in highly efficient floor plates and modern open floor layouts. Since the renovations, cash flow grew almost eightfold from $8 million in 2016 to $62 million in 2021, more than 631,000 sf of lease-up since 2017.

Credit tenants comprise approximately 67% of the total rent (61.9 of the NRA) and Long Term Credit Tenant (LTCT) comprise approximately 16.7% of the total rent (12.9% of the total NRA) at the property. Based on the June 2021 rent roll, One SoHo Square is also home to the U.S. headquarters of these five tenants: Flatiron, MAC, Warby Parker, Glossier, and Double Verify.

The property has a minimal rollover risk of 22.3% of the NRA over the loan term and a decent WA remaining lease term of 9.2 years (more than two years beyond the loan term), which provide a stable stream of cash flow.

The sponsor will contribute approximately $2.31 million in cash equity at closing. Based on an appraised value (as-is) of $1.35 billion, there is $445 million of implied equity in the transaction. DBRS Morningstar views cash-in financings more favorably than those where the sponsor is withdrawing significant equity, which can result in less incentive.

Stellar Management is one of New York City’s premier owners and operators of residential and commercial properties focusing on integrating real estate acquisitions, development, reposition, and property management. Stellar currently owns and manages over two million square feet (sf) of office space and 1.3 million sf of retail space.

The ongoing coronavirus pandemic continues to pose challenges and risks to virtually all major commercial real estate property types and has created an element of uncertainty around future demand for office space, even in gateway markets that have historically been highly liquid. As more firms spend time exploring remote work and revisiting their space needs during the pandemic, New York City office recovery will surely be among the markets to face this challenge. While some tenant spaces are not completely occupied as employees have continued to work from home during the pandemic, all tenants are now open and operating. Additionally, only one retail tenant, Torch & Crown (representing less than 1% of the total rent), received rent abatement/deferral during the pandemic. This tenant has recently caught up with its rents, according to the sponsor.

JUUL and Flatiron have 100% and about 18% of their spaces marketed for sublease, respectively. DBRS Morningstar incorporated a partial lit/dark analysis into the valuation to account for the sublease spaces. JUUL has been current on rents throughout the pandemic. Flatiron’s subleasing was part of its corporate business plan with the intention to initially sublet some of the space to short-term tenants until the company expands and grows into the space. The expansion plan was delayed because of the pandemic. Flatiron Health originally put up approximately 49% of its leased space for sublease during the pandemic, and has subsequently pulled back the majority of them from the sublease market. Of the 18% sublease space, Flatiron has recently inked a three-year sublease contract on a 30,668 sf space in the west building. Flatiron’s parent company, Roche Holdings, has also provided a comfort letter as support. All Flatiron’s sublease spaces are built out and tenant ready. JUUL sublease spaces, however, are in white box form.

The DBRS Morningstar issuance LTV is high at 95.4%, based on the trust debt. The capital stack also includes $120.0 million of mezzanine debt. The leverage increases to an all-in DBRS Morningstar LTV of 109.9% when the mezzanine loan is factored in. The high leverage point could result in an elevated refinance risk and loss severities in the event of default. A default on the mezzanine debt may also potentially complicate workout negotiations or other remedies for the trust.

The property’s Industrial & Commercial Abatement Program (ICAP) tax abatement schedule is expected to be in full effect for four years on the west tower and three years on the east tower, then phased out over 10 years. The property is also subject to a transitional tax reassessment where the assessed value of the property will be increased and phased-in over a period of approximately five years. The increase in real estate taxes because of the tax reassessment will be passed through and reimbursed by the tenants because the in-place office leases are predominantly modified gross leases with base-year stop. As such, the gross rents will increase as the ICAP abatement burns off and eventually expires.

The debt yield trigger for the cash flow sweep event is low at less than a 5.0% for two consecutive quarters. There is no debt service coverage ratio (DSCR) trigger requirement. The low thresholds increase the term and balloon default risks. Per the loan agreement, the borrower can partially defease to avoid a debt yield cash management trigger.

The liability of the carve-out guarantor is capped at 10% of the then-outstanding loan amount for bankruptcy events and full recourse is triggered only by such bankruptcy events or if certain transfer provisions are violated. In addition, the guarantor under the mortgage loan is required to maintain a minimum net worth of at least $200 million; however, there is no liquidity requirement. DBRS Morningstar views these factors as credit negative and relatively weak in the context of the size of the mortgage and mezzanine loans.

The guarantor on this loan is Gluck Family Trust. This effectively limits the recourse to the sponsor for bad act carveouts. “Bad boy” guarantees and consequent access to the guarantor help mitigate the risk and increased loss severity of bankruptcy, additional encumbrances, unapproved transfers, fraud, misappropriation of rents, and other potential bad acts of the borrower or its sponsor.

The borrower has a one-time right to incur up to $90.5 million of future mezzanine debt subject to certain conditions which include, among other things, (1) a maximum LTV of 67%, (2) a DSCR of no less than 2.22 times, and (3) a debt yield of no less than 6.82%, with such LTV, DSCR, and debt service coverage ratio inclusive of the additional mezzanine debt at the time of closing of the loan. Rating agency confirmation is required in connection with the incurrence of a future mezzanine loan.

The borrowing entity is formed by three tenants in common (TICs). While the loan is structured with customary protections with respect to the TIC structure, this type of ownership structure typically adds layers of complexity and the potential for diverging interests in the event of default.

Ongoing reserves. including replacement, tax and insurance, rollover and excess cash reserves, will be collected only subsequent to a cash sweep period being triggered.

Goldman Sachs Bank USA, DBR Investments Co. Limited, and Bank of Montreal originated the $785 million whole loan, which pays an assumed fixed-rate interest of 2.725% on an interest-only (IO) basis through the entire seven-year loan term. Additionally, the mortgage lenders are expected to provide a $120 million mezzanine loan for a total debt of $905 million. The transaction represents a cash-in refinance of the existing debt on the property. The loan will be used to pay off the existing debt of approximately $900 million and pay closing costs of approximately $7.3 million. The transaction has an elevated DBRS Morningstar Issuance LTV of 95.4%, based on the whole loan. The LTV based on the appraised value of $1.35 billion is 58.1%. Including mezzanine debt, the DBRS Morningstar issuance all-in LTV is 109.9%, compared with the appraisal’s all-in LTV of 67.0%.

The $785 million whole loan comprises 23 promissory notes: 20 senior A notes totaling $470 million and three junior B notes totaling $315 million. The SOHO 2012-SOHO transaction will total $316 million and consist of three senior A notes with an aggregate principal balance of $1 million and the three junior B notes with an aggregate principal balance of $315 million. The remaining companion senior A notes will be held by the originators and may be included in future securitizations. The senior notes are pari passu in right of payment with respect to each other. The senior notes are generally senior in right of payment to the junior notes. The mezzanine loan has a seven-year term and pays an initial interest rate per annum of 5.05%.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

All ratings are subject to surveillance, which could result in ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by DBRS Morningstar.

DBRS Morningstar provides updated analysis and in-depth commentary in the DBRS Viewpoint platform for this transaction. For complimentary access to this content, please register for the DBRS Viewpoint platform at www.viewpoint.dbrsmorningstar.com The platform includes issuer and servicer data for most outstanding CMBS transactions (including non-DBRS Morningstar rated), as well as loan-level and transaction-level commentary for most DBRS Morningstar-rated and -monitored transactions.

Notes:
All figures are in U.S. dollars unless otherwise noted.

With regard to due diligence services, DBRS Morningstar was provided with the Form ABS Due Diligence-15E (Form-15E), which contains a description of the information that a third party reviewed in conducting the due diligence services and a summary of the findings and conclusions. While due diligence services outlined in Form-15E do not constitute part of DBRS Morningstar’s methodology, DBRS Morningstar used the data file outlined in the independent accountant’s report in its analysis to determine the ratings referenced herein.

The principal methodology is North American Single-Asset/Single-Borrower Ratings Methodology (March 2, 2021) which can be found on dbrsmorningstar.com under Methodologies & Criteria. For a list of the structured-finance-related methodologies that may be used during the rating process, please see the DBRS Morningstar Global Structured Finance Related Methodologies document, which can be found on dbrsmorningstar.com in the Commentary tab under Regulatory Affairs. Please note that not every related methodology listed under a principal structured finance asset class methodology may be used to rate or monitor an individual structured finance or debt obligation.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

For more information regarding the structured finance rating approach and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/359905.

The full report providing additional analytical detail is available by clicking on the link under Related Documents below or by contacting us at info@dbrsmorningstar.com.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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